As everyone who studies FINRA’s Regulatory Notices is already well aware, two days from now, FINRA’s rule requiring background checks on prospective registered representatives goes into effect. A lot of what the new rule mandates is not new, but, as there are some things that clearly were not required before, it is worth taking a few minutes to understand what FINRA has always required (but hasn’t necessarily enforced), and what new things the rule now makes mandatory.
I have blogged before a bit about existing hiring requirements. First, according to the boilerplate currently on Form U-4, before a broker-dealer registered a prospective representative, the broker-dealer had to certify that it had spoken with the applicant’s former employer(s) for the past three years. The new rule does not change this. Thus, even though most former employers will not share any of the sort of information in which a potential new employer would really be interested – in order to avoid any potential defamation actions – it is still necessary to reach out to those former employers at least to try and learn something about an applicant. Naturally, as with all things, if you don’t document these efforts, in FINRA’s eyes, you never made those calls.
Second, old Rule 3010(e) required firms to “ascertain by investigation the good character, business repute, qualifications, and experience” of any applicant. Although FINRA never defined what it meant by “investigation,” the rule did expressly require that an applicant’s most recent Form U-5 be reviewed. Other than changing “repute” to “reputation,” the new rule maintains all this language.
So, these two requirements remain the same. What, then, is new? There are two principal changes. First, in addition simply to reviewing the Form U-5 and speaking with former employers, FINRA seems to have expanded what it believes the “investigation” should encompass. According to Reg Notice 15-05, “[f]irms also may wish to consider private background checks, credit reports and reference letters.” Like the two existing requirements, this is a pre-registration requirement, i.e., it must before undertaken before the U-4 is filed.
The second change is the big one. Under new Rule 3110(e), within 30 days after a U-4 is filed, a firm must “verify the accuracy and completeness of the information” in the U-4. Moreover, “at a minimum,” that verification process “shall . . . provide for a search of reasonably available public records.” There is a lot going on here, so let’s explore it.
First, some good news. In a refreshing (albeit rare) demonstration of logic, FINRA expressly acknowledges that if the U-4 information is verified as part of the pre-registration process, then it need not be duplicated after the U-4 is filed. Moreover, if, for some reason, the information cannot be verified within 30 days, FINRA appears to be ok with that, as long as the firm procedures “provide that the verification must be completed as soon as practical, and the firm should document the basis for the delay.”
The bigger issue is the need for the search of “reasonably available public records.” What does this mean? First, the search must be “national” in scope, although FINRA notes there may be circumstances that will require public records searches in foreign jurisdictions. Second, “public records,” according to FINRA, “include, but are not limited to general information, such as name and address of individuals, criminal records, bankruptcy records, civil litigations and judgments, liens, and business records.” But, because the Rule only requires a search of “reasonably available public records,” FINRA acknowledges that looking at all of these things may be unreasonable. At a minimum, therefore, FINRA will apparently only require a search of criminal records, bankruptcy records, judgments and liens.
Although FINRA expressly disclaims any “requirement” to obtain credit reports on applicants, FINRA does include the review of credit reports among the ways the rule can be satisfied, along with (1) fingerprint checks, (2) searching a reputable national public records database, such as LexisNexis, and (3) reviewing a consolidated report from a specialized provided, such as Business Information Group, Inc. that includes criminal and financial public records. Indeed, FINRA has contracted with BIG to allow broker-dealers to obtain reports on applicants for a very fair price of $10 – $13 per individual. UPDATE: An old friend of mine, after reading this post, wrote to tell me that he has accepted FINRA’s invitation to use BIG on behalf of his broker-dealer. He reports that there is a difference between BIG’s “Disclosure Monitoring Report” (which he describes as “not really live monitoring, but something that you might run annually”), on the one hand, which goes for $11.75 for the credit and criminal check, and, on the other hand, BIG’s “New Hire” packages, which run around $53 with no criminal check (perhaps useful for somebody not being fingerprinted) and $108 with the criminal check, plus the availability of several add-on services. He also advises that getting set up with BIG is quite a process that can involve multiple contracts, depending on which services you are using, plus an onsite visit to verify that you are a real business. Thanks, Kevin, for the insight!)
There are a couple of nuances to bear in mind. First, if you are going to run credit checks, it is important that you are aware of the requirements of the Fair Credit Reporting Act. Under the FCRA, it is necessary to get permission from someone before you run their credit report. Second, if you make a hiring decision based on someone’s financial history, the FCRA also erects hoops – generally in the form of notices that must be provided to the applicant, both before and after the adverse hiring decision is made – that must be jumped through to avoid possible penalties. For example, if an otherwise qualified individual is not hired because he or she has a bankruptcy disclosure, notification of that decision must be delivered to the applicant, who can then, theoretically, challenge it. (FYI, a similar notice is required if the adverse hiring decision is based on the applicant’s criminal record.)
Finally, it is a very fair question to ask: what do firms do about the annual affirmations obtained from existing registered representatives about the currency and accuracy of the information on their Forms U-4? Will it be sufficient simply to rely on those affirmations, as most firms presently do, or will it be necessary (to be deemed reasonable by FINRA) to independently verify on an annual basis that the information on the registered representatives’ Forms U-4 remains accurate? Remember, applicants certify to the accuracy of the information on Form U-4 when they first apply, but, as the requirements of the new Rule demonstrate, broker-dealers are not permitted simply to rely on that certification, they must independently verify everything. If that is true at the front end of the relationship between a rep and his firm, why would it be any different after that relationship already exists? Unfortunately, I believe that blind reliance on reps’ affirmations, sooner or later, will be expressly deemed by FINRA to be inadequate.
On its face, these rule changes seem simple enough, and largely a continuation of existing requirements. On closer examination, however, the new rule imposes serious and significant new responsibilities on broker-dealers, and the failure to meet these responsibilities could very well result in Enforcement actions, not to mention negligent hiring claims in arbitrations.
 I say “seems to have” given FINRA’s use of the phrase “may wish to consider.” Clearly, FINRA isn’t requiring that broker-dealers use these tools, or even suggesting that the use of such tools constitutes some sort of safe harbor. But, it would be a very foolish broker-dealer that doesn’t follow the “advice” that FINRA provides here.
 Using BIG, however, is not deemed by FINRA to be a “safe harbor.”